Beyond Krugman's Inflation

At least he's not a politician.

I admire Paul Krugman because he is so much more reasonable than most of his critics. We are here today to review an opinion piece of his, something my wife found in our local paper. You can find it here.

Krugman says we've been in this situation twice before, and says both times policymakers "stopped worrying about depression and started worrying about inflation" much too soon. He says that's happening again now. He says there's no need for worry about inflation, because "a rising monetary base isn't inflationary when you're in a liquidity trap."

Krugman also says something I totally agree with: "What about all that government borrowing? All it's doing is offsetting a plunge in private borrowing -- total borrowing is down, not up. Indeed, if the government weren't running a big deficit right now, the economy would probably be well on its way to a full-fledged depression."

Now I'm gonna be explicit about this, so read slow: I agree with Krugman that "all that government borrowing" is not the problem right now. But of course it's a problem. It's part of the central problem: All that borrowing... All that lending... All that debt. The central problem -- debt -- is the problem that got us where we are today. But now that we're here, we have a new problem: namely, the threat of depression. The moment this new problem arose it became a thousand times more significant than debt.

In fact, debt is a problem for one reason: eventually it hits the fan and the threat of depression becomes the greater problem. The obvious solution is to stop accumulating debt before it hits the fan. A lot of people are angry now (I think) because this is so very obvious.

However, it is too late for anger. It already hit the fan. At this point debt is no longer the problem. Suddenly, the prime directive is different. Our task now, at any cost, is to avoid falling into depression. If that means more debt, so be it. If it means printing money, so be it. The trick is to be sure what it means, before it's too late.

Let me make a long story short and just get to the point: It doesn't mean more debt. But it does mean printing money. It has to be done. It's the only way to correct the imbalance between (excessive) debt and (relatively insufficient) base-money.

Look: When you borrow a dollar, you create a new dollar of money. (This is Economics 101.) So, when you pay back a dollar, you destroy a dollar of money. (This is an Arthurian corollary.)  OK, so there is a simple solution to our debt problem: We print money, and use it to pay off debt.

Printing creates new dollars of money, just like borrowing. And then paying off debt destroys those new dollars at the same time it destroys the debt. Isn't it simple?

As a side benefit, we're printing money instead of borrowing it, so we're not building more debt in the process.

This nifty trick goes against everything we know to be true about printing money. It's true, though. It works because of the "liquidity trap" that Krugman wrote about. In a normal economy, when you print more money you get more spending, and that pushes prices up. But in a liquidity-trap economy, spending doesn't want to increase no matter what you do. That's why it's relatively safe to print money now.

Here's the plan: We print money and use it to pay off debt in a big "debt-forgiveness" operation. When money pays off debt, the two cancel each other out. The debt ceases to exist and the newly printed money ceases to exist. It's almost no-strings-attached.

Here is the string: As debts are paid off and the money returns to its place in savings accounts and such, the banks find themselves liquid again. That's good, because it means the banks are healthier. But the catch is, this plan makes our banks healthy and liquid and more willing to lend. And when they start lending, that money goes out into circulation again where it can push prices up. That's the catch.

As Krugman says, we don't have to worry about inflation while we're in a liquidity trap. But wiping out debt and getting money back into banks frees us from the liquidity-trap. And then the inflation can strike.

Funny thing: It won't be the newly printed money causing that inflation. The new money ceases to exist as debt is paid off. But the existing money in savings, which was not available for lending because it was lent already, is freed up and available to be lent again. So it is existing money in savings, not newly printed money, from which the threat of inflation will come. Remarkable.

There's good and bad in everything. But with this debt-forgiveness plan, the good comes right away, and the bad comes a little later. It's a good trade-off.